Research and development (R&D) spending isn't the sole indicator of how a nation, region or industry will perform. It is, however, a fundamental contributor to economic growth - along with such factors as science, technology, engineering and mathematics education levels, capital markets, healthcare, infrastructure, property rights and immigration policy. According to Dow Jones VentureSource, corporate R&D spending in the United States has been on a steady decline since 2001, falling from 34.4% of revenue in 2001 to 5.7% in 2011. By 2014, R&D spending recovered a bit, but still remained below 7.0%.
The causes for America's private-sector R&D stagnation are complex, ranging from impatient investors and uncertain returns on investment to economic policy uncertainty and reduced federal funding. Given the precipitous drop in research and development spending, it would be easy to conclude that the United States is in danger of losing its spot as the undisputed world leader in research and development.
However, this week's chart shows a more complex story, with corporations shifting money once devoted to in-house R&D towards corporate venture funds that invest in start-ups with promising technologies. Corporate investing as a percentage of overall venture capital financings has steadily been on the increase since 2009. Despite their shrinking R&D budgets, corporations seek to continue to access innovative, disruptive technologies. Venture capital serves as an efficient vehicle that enables corporations to stay abreast on technology trends and explore potential acquisition targets when they deem it appropriate.
Using these venture capital investment arms as a direct replacement for traditional R&D departments allows corporations to invest at a point when technologies are partially de-risked and somewhat proven rather than at the conceptual phase. This migration in R&D spend has changed the risk profile of corporate research and development while creating a unique opportunity for venture capital investors.
Key Takeaways: While corporate venture capital investing is not new, its recent growth serves to strengthen the potential for a merger or acquisition as an exit opportunity for many venture-backed companies. In fact, according to Crunchbase.com, about one-third of corporate venture-backed startups have been acquired versus 10 percent of startups with funding from only private venture capital. Corporate venture arms have expanded the exit environment for venture-backed companies. This dynamic should reduce the industy's reliance on the IPO market, serving to somewhat smooth out venture capital returns over time.
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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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